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Thoughts On 2019 – Investor Pessimism And The Potential For P/E Expansion

SeekingAlpha

Take any forecast or anticipated return dialogue for 2019 with a considerable grain of salt.

In 2017, this weblog’s forecast for the S&P 500 was fairly strong, in search of a 20% yr the place actually the S&P 500 returned 21.5-22% final yr, probably in anticipation of tax reform.

In 2018, the S&P 500 forecast was much less correct since an “average” yr was predicted for the S&P 500 (and I assumed given the S&P 500’s return as of September 30, 2018, the forecast can be too low) of between 7% and 12%. As an alternative, the S&P 500 forecast was far too excessive in a yr the place S&P 500 earnings will develop 23-25% versus 2017.

Take into consideration that: The S&P 500 will probably have a low-to-mid-single-digit NEGATIVE return in a yr the place S&P 500 earnings grew nicely over 20% for the calendar yr (Kinda shoots a gap within the boat for the aim of this weblog, which is speaking S&P 500 earnings forecasts).

What makes it even worse, as final night time’s weblog posits, the S&P 500 “organic” earnings progress price (ex tax-reform affect) was nonetheless +14% (per IBES for Refinitiv), so – once more – we had mid-teenagers natural S&P 500 earnings progress in 2018 and nonetheless a damaging S&P 500 return for the yr.

Basically and from a macro perspective, that is what I might wish to see occur in 2019:

  • The Fed flip dovish (which means a slowing or stopping of tightening financial coverage) given the absence of any actual inflation. 10 years into an financial restoration, and with a three.7% unemployment and stretched labor markets, and there’s STILL no actual menace of wage or worth inflation. It’s “unanticipated” inflation that spooks the Treasury market anyway, however you’d assume if US buyers have been to see wage inflation, it might have occurred by now. I am an enormous believer that it is wage moderately than commodity inflation that may do within the Treasury market and see rates of interest spike markedly.
  • US-China commerce talks get put behind us. Whereas most buyers blame the Fed for the unfavorable S&P 500 return this yr, consider the uncertainty commerce talks have created since 35% of the S&P 500 income is non-US and CEOs do not but have the brand new playbook. Jeff Miller, the superb blogger at “Dash of Insight” www.dashofinsight.com) wrote in early December ’18 that the commerce talks can be extra “process” than massive headlines (like Mexico and Canada have been), so the rice deal by China introduced Friday, December 28th, and the 2 month hiatus on auto tariffs introduced a number of weeks in the past are small, tangible steps very similar to Jeff Miller advised would occur.
  • Brexit: The world’s fifth largest financial system must get this resolved. I do assume the sluggish progress in Europe is a perform of the Brexit realignment and like Fed coverage and China commerce, it slows down determination-making on the company board and CEO degree. It needs to be troublesome to know find out how to do three-5 yr planning for capex and funding when you do not know the playbook and the principles for even the subsequent 12 months.

The key factor to those three “macro” occasions is that we should always have some substantial decision to all of those by March 1st. The first quarter of 2019 shall be crucial: Brexit is headed for a March 1 deadline and China commerce talks will doubtless see some agency conclusion by then too, because the US auto tariff hiatus introduced a couple of weeks in the past expires March 1, ’19. May we hear one thing totally different out of Powell and the Fed? We’ll know extra on January 31, the date of the subsequent FOMC assembly.

  • S&P 500 forecast for 2019: Excessive-single-digit to low-double-digit return for 2019, based mostly on 7-10% S&P 500 earnings progress subsequent yr. Anticipate a yr of “PE expansion,” too. The retail investor pessimism round 2019 is palpable. Expectations are so very low for fairness returns. That is a superb factor for lengthy-time period buyers. Buyers have not seen two consecutive years of destructive returns for the S&P 500 because the Nasdaq fell 80% from early 2000 by way of the lows in 2002. Earlier than that, it was 1973-1974 the place the S&P 500 declined 2 years in a row.
  • Bloomberg Combination (NYSEARCA:AGG) forecast for 2019: After 2 destructive years of primarily adverse Combination returns for the Bloomberg Barclays AGG, anticipate a constructive yr, however nonetheless single digits. When it comes to my very own confidence round probabilistic returns, I feel the bond market might supply paltry returns for years. Then once more there’s simply no inflation. That is the important thing to this complete asset class.
  • US greenback – Flat to weaker after the robust yr in 2018, until Jay Powell and the Fed ignore everyone and need to hear Company America squeal. I might assume the Treasury would lean in the direction of “dollar weakness” because it helps to take some strain off US exports to China. Let the greenback weaken slightly.

Portfolio modifications anticipated in 2019:

1.) Shoppers have seen their rising markets and non-US weights improve progressively this yr from three-5% to as much as 10% as of at this time. EEM and VWO as of this writing have 5-yr “average annual” returns of simply 1%, whereas SPY’s 5-yr return is Eight.25% per Morningstar knowledge. The three shopper holdings for Rising Market publicity are EEM, VWO after which the Oakmark Worldwide Fund managed by David Herro. Herro has a superb lengthy-time period monitor document (though the 12-month numbers look fairly horrid, which is why I am shopping for into it for shoppers) and can purchase into developed markets as nicely. Something non-US as we speak has gotten crushed. We have been early and fallacious on lifting shoppers’ rising markets weight in 2018,however the weight presently is heading in the direction of 10% and the utmost weight might be 15%.

Sector overweights in Financials will stay the identical. Shoppers might be nearer to a impartial weight in Know-how and Shopper Discretionary and Communications and Healthcare.

With these 5 sectors of the S&P 500, buyers get about two-thirds of the S&P 500’s complete market cap.

2.) With a much less restrictive financial coverage in 2019, some excessive-yield (NYSEARCA:HYG) has began to be purchased for shoppers in addition to a excessive yield bond mutual fund. Excessive yield credit score spreads have widened out to 7-Eight% as of yr-finish 2018 versus the summer time lows close to 5% which is not nice however after the Fed’s spherical of fee hikes, maybe we see a extra secure bond market in ’19. Shoppers have been in a Schwab larger-yielding cash marketplace for over 2 years, simply strolling up the brief-finish of the yield curve, so some money can be reallocated into some credit score unfold product. Shoppers have seen good “alpha” from fastened revenue allocations, however the returns are so diminished relative to equities, the efficiency dialogue by no means will get a lot recognition from the shopper. The flatter yield curve worries me – simply not the best way you hear within the mainstream media.

three.) One of many favourite elements of the marketplace for me personally is the “Original Gangster” shares from the 1990s which now embrace Pfizer (NYSE:PFE) and even Merck (NYSE:MRK) from the massive-cap pharma period, which are repositioning their enterprise fashions to set themselves up for progress within the subsequent 10-20 years. Microsoft (NASDAQ:MSFT) will possible stay shoppers’ largest holding, as will Schwab, after which I attempt to search for lengthy, underneath-performing and crushed-down names that would get a catalyst. Cisco (NASDAQ:CSCO) is wanting good and with the late-2018 pullback within the S&P 500; it is being purchased for shoppers. Inside Tech, there’s all the time the “new growth companies” versus the “old growth companies,” and because the present bull market ages, shoppers see extra “old growth” with the potential for brand spanking new concepts being owned. These corporations do not precisely match the “value” class, however perhaps simply “cheaper growth” is the best way to label them.

What are the most important worries headed into ’19?

  • Sudden and unanticipated inflation which can drive Jay Powell’s hand to not again off on Fed funds fee will increase, and “quantitative tightening”.
  • The commerce talks with China which pressure the President and the commerce workforce to play hardball.
  • A a lot stronger greenback which might outcome from the primary fear.

Abstract/conclusion: Consider one yr in the past, and the way bullish buyers have been with tax cuts and expectations for an incredible 2018. Actuality was a harsh shock. I do assume expectations are too low for 2019, and we’ll see a return to a extra regular yr of “PE expansion”. S&P 500 earnings ought to develop at Eight-10% in 2019, once more a extra regular yr.

One ultimate phrase of recommendation to readers: take all this with a wholesome dose of skepticism and pessimism, particularly the forecasts. The purpose for writing the weblog is to drive me to put out the logic for portfolio actions and selections. Readers can agree with them or not.

Thanks for studying. Have an exquisite New Yr.

SeekingAlpha

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